Gold: financial repression or bust?

Gold continues to puzzle and excite in equal measures. After bouncing from the $1680 zone, traders began to ask if this was the start of the big move higher many had been waiting for. The rally beyond the 20 day moving average added hope to the mix, until the move reversed from the $1808 support. Now, the price is right back where it started.

Price action traders may claim that the lower high signifies further weakness ahead, with the lack of sustained buying evidence that higher prices cannot be sustained. The return for a fifth touch of the $1680 zone could also be seen as a clue that lower prices lie ahead. It’s often said that the more times a level gets hit, the weaker it gets.

Talking in absolutes around technical levels doesn’t really make sense though. Ultimately, it’s order flow that moves the needle. Price changes are determined by imbalances between buying and selling over a given time period. If the story drastically changes, nobody cares if a support or resistance has been tagged five or a hundred times before.

There are a few factors that frequently crop up as possible catalysts for gold.

US bond yields are one of these. There’s a clear negative correlation between the 10 year yield and the gold price. Like most correlations it’s intermittent, rather than permanent.

Here’s the 10 year bond yield overlaid with gold. The yield is on an inverted scale to show the relationship more clearly:

The theory behind this relationship is that gold is a zero yield asset, whereas bond yields are positive. Put another way, why own gold if you can earn better yield elsewhere?

It’s a good question. The answer is in real yields. The yield after inflation has been ‘deducted’ from the returns. This sounds a lot more complicated than it is. Essentially, if inflation is 8% and bonds yield 4%, that’s a negative real yield regime. If inflation is 4% and bonds yield 8% that’s a positive real yield regime.

But these are competitive markets, so it would be hard to imagine that situation lasting long (if it ever happened at all). That kind of positive yield would likely be eaten up by demand from investors and bring the yield closer to the rate of inflation.

Let’s look at an example from this year. The US treasury publishes the real yields here every day.

At the start of 2022, these were negative across the 5 to 30 year curve.

01/03/2022

• 5 Year: -1.58%
• 7 Year: -1.25%
• 10 Year: -0.97%
• 20 Year: -0.55%
• 30 Year: -0.36%

Gold rallied until the 8th of March. From the 1790 to 2050 price zones. It’s now trading below 1700. Could real yields be the culprit?

If you go through the data, the 8th of March seems to mark the point that real yields were most negative. They haven’t been as negative since, and are now well into positive territory:

• 5 Year: 0.87%
• 7 Year: 0.86%
• 10 Year: 0.85%
• 20 Year: 0.99%
• 30 Year: 1.11%

So, it may be fair to conclude that gold could outperform in regimes of negative real yields/financial repression (or when fears are high that the regime is changing to one of financial repression).

Recession fears could drive a flip back towards a negative real yield regime. If investors begin to feel that a recession is imminent, the safety of bonds may be sought, driving the price of those bonds higher (and yields lower).